Capital One (COF, Financial) has increased its net worth by over 2,200% in 20 years thanks to the bank retaining the bulk of its earnings and prudently investing those retained earnings. The bank has grown its tangible book value at a higher rate of return then its larger competitors like JPMorgan (JPM, Financial) and Wells Fargo (WFC, Financial). The only other bank that has increased its net worth by over 2,000% has been U.S. Bancorp (USB, Financial). Capital One has been a highly profitable bank with prudent management who don't engage in risky activities. This conservatism has rewarded shareholders of Capital One very well. Right now is a great time to start building a position in a well-run bank like Capital One.
Business overview
Capital One specializes in credit cards, home loans, auto loans, banking and saving products. The bank is the eighth largest by total assets and deposits in the U.S. and has over 2,000 ATM throughout the country. Back in the 1990s, Capital One pioneered the mass marketing of credit cards, now the bank is the fourth largest customer of the U.S. Postal Service. Over the last 20 years Capital One has increased its net worth by over 2,000%, outpacing all its competitors except U.S. Bancorp. How did Capital One outperform its competitors while offering pretty much the same services and products? Well, Capital One does two things really well. First, Capital One retains all of its earnings, and second, management is very conservative and avoids risky activities.
Financial
In 2015, the bank had operating earnings of $5.81 billion on revenues of $23.41 billion. The bank continues to grow its revenues and its operating earnings through its prudent stewardship. However, operating earnings were lower in 2015 than in 2014. The driving force behind Capital One's over 2,000% increase in net worth is its habit of retaining the bulk of its earnings. In 2015, the bank retained $27.4 billion in earnings, which exceeded its annual revenues of $23 billion. Capital One, unlike most banks, produce far more in free cash flow than it does in operating income. Recently the bank announced that it would increase its share buybacks by another $500 million. This puts Capital One's share buyback at over $5 billion.
Valuation
Capital One is selling for less than 10x its operating earnings and 0.77x its book value. Warren Buffett has said numerous times that banks that return on assets exceeding 1% should trade for more than book value. Capital One has annual returns on assets of 1.29%. The bank produced $5.8 billion in operating income or $10.73 per share. Currently Capital One is selling for 8.6x its current operating earnings. On the other hand, Capital One has produced on average $9.6 billion in free cash flow or $17.45 per share. The bank produces more in cash flow than its does in operating earnings. Capital One has maintained an average FCF margin of 40% over the last 10 years. If the bank sold for 10x its operating earnings and 10x its free cash flow, shares would trade between $107.3 to $174.50 per share. At its current price, long-term investors are getting Capital One at a bargain taking into account the bank's long term history of increasing its net worth.
